Prohibited Transactions in a Self-Directed IRA (You Know It's a Prohibited Transaction When...)

Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
SPEAKER_00 (00:06):
Welcome everyone to the Directed IRA podcast.
This is Matt Sorensen joined bythe great and powerful Mark J.
Kohler.
We are two tax lawyers here toteach you what is a prohibited
transaction when you're using aself-directed IRA.
These are IRAs that can own inreal estate, private companies,
you can invest crypto.
All these private assets you canactually own with your IRA.

(00:26):
But there's one critical rule,the most important rule I should
say, that you need to know.

SPEAKER_01 (00:30):
Is you're gonna have fun during this podcast.
That's why I'm here.
Yes, yeah.
Can we do that?

SPEAKER_00 (00:34):
Yeah, I'm gonna obviously lobbying for comic
relief on the podcast today.
I'm like, we need to be serious.

SPEAKER_01 (00:40):
I know, he's like plowing through.
I'm like, I gotta get a word inhere, you know, to make sure you
guys are gonna have a greattime.
But apparently you're sayingthere's a number one rule.

SPEAKER_00 (00:48):
And it's the prohibitive transaction rule.
And it's really once you knowit, you can be super powerful
and unstoppable with yourself-directed IRA.

SPEAKER_01 (00:57):
I love it.
And I was like, I love this timebecause I love Jeff Foxworthy.
We have some younger people herewho have never heard of this guy
who said, you know, you're aredneck when.
Anybody remember that joke?
Well, we're here to tell youtoday.
We're gonna spatter or sprinklein some of these great jokes of
you know it's prohibitedtransaction when.
So stay tuned.
It's gonna be good.

SPEAKER_00 (01:16):
Are you gonna give us one on the day?

SPEAKER_01 (01:18):
I'm gonna lead out of one.
Okay, I'm gonna lead with one.
Okay, so everybody, you'reyou're gonna, you're never gonna
forget.
See, this the beauty of thispodcast today, you're never
gonna forget what a prohibitedtransaction is again, and you're
gonna make so much freakingmoney in your IRA because we're
gonna make this fun to learn.
Okay, so I okay, you want one ofmy?
I'm gonna go with a holiday one.
You know it's a prohibitedtransaction when your IRA owns a

(01:40):
vacation home and somehow yourwhole family accidentally spent
Christmas there.

SPEAKER_00 (01:46):
If you're not laughing right now, that's
because you thought that wasgreat.
Yeah, that's because you know,sometimes delivery matters, you
know.
Um, you know, comedy's all abouttiming.
Okay.
And also, you probably don'tknow what a primitive
transaction is.
Because if you did know, youwould be laughing.
Okay.
Because that was funny.

SPEAKER_01 (02:03):
So we know you get it, your whole family
accidentally.
Yeah.
Yeah.
Whatever.

SPEAKER_00 (02:08):
Because they can't stay there.
So, all right, let's unpack whatis a primitive transaction.

SPEAKER_01 (02:13):
I like it.
Okay.
Okay.

SPEAKER_00 (02:14):
Let me say one thing on at the outset here.
Your IRA can really own anyasset allowed by law.
It just can't own lifeinsurance, collectibles, or S
corporation stock.
Everything else is fair game.
It can own the duplex down thestreet, it can own an Airbnb, it
can own a vacation rental, butyour family can't stay there.
And this is because of theprohibited transaction rule.

SPEAKER_01 (02:32):
And I want to add to this too.
A lot of people hear prohibitedtransaction rule, and they think
it's all about stuff you can'tbuy.
It's not that.
You got world is your oyster.
The prohibited transaction ruleis what you do with it after you
buy it or who you buy it from.
That's what the prohibitedtransaction rule is about.
It's not about what you'rebuying, it's how you're buying.

SPEAKER_00 (02:54):
Yeah, and there's really three varieties of this.
We're gonna teach them here,we'll get through it.
It's not, it's pretty simple.
Okay.
The first is what's called a perse prohibited transaction.
And like Mark said, this isabout who is your IRA, once you
have money in your self-directedIRA, who is it transacting with?
If my IRA is buying the duplexdown the street as a rental
property, who's selling that?

(03:15):
Who's selling that property tomy IRA?
So I have a primitivetransaction.
If I have an IRA, transact withthe disqualified person.
Well, the whole point of havinga retirement account is to have
one.
So I got one and I gotta makemoney, so I gotta transact it.
But who is on the other side ofthe transaction?

SPEAKER_01 (03:33):
And this is where people start to play games and
want to benefit themselves andtheir IRA at the same time.
And themselves means your mom,your dad, your kids, your
spouse, you're trying to benefityour family somehow and have
your IRA provide some cool assetor payment or use of property to

(03:54):
your family.
That's where, and this is thecrazy part.
Just this principle alone, yourIRA can make so much more money
than a Wall Street structuredproduct.
That's the beauty of it.
But then some people push theenvelope even farther and say,
ooh, ooh, that's great.
Now I'm gonna use that rentalproperty.
No, just just enjoy theincredible ROI.

(04:15):
Don't screw it up by trying touse it.
So so I'd like so first exampleis I like your point.
Prohibited transact transactionnumber one is I am doing a deal
with a person that I shouldn't.

SPEAKER_00 (04:28):
I'm either buying a property from them or selling
it, I'm leasing it.
So let's just go through theclear example here.
My IRA is buying the duplex downthe street, and the seller is my
father.
Okay.
Well, my father's on this listof who is a disqualified person.
It's what it's called in the taxcode.
This is section 4975.
I did tip warn you, we're taxlawyers, okay?
All right, you might think we'recomedians or some, you know,

(04:50):
well, I don't know.
I know I don't know what you'rethinking right now.
Okay, I don't really don't know.
Okay, but you're still listeningand watching.
Okay.
So um, but your father'sprohibited.
Now, you're prohibited.
So this is what we get a lot oftimes, too, is they're like, hey
Matt, I own this stock or I gotsome options in this company I
work at, and they've gone up invalue.
And if I sell them, I'm gonnapay all this tax.
Can I just sell them to my RothIRA?

(05:11):
Well, now let's look at thatagain.
This is your IRA buying stock, atransaction or options here from
yourself.
You're disqualified.
So this would cause a prohibitedtransaction as well.
Now let me change one fact here,and then I'll let it let you
take it from me.
I will defer to you, I will, youknow, yield, I will yield the
balance of my time.
All right.
Okay.
Is let's say you're like, okay,let's go back to this real

(05:33):
estate example.
Now let's say that your IRA isbuying the duplex down the
street, but the seller's yoursister.
Your sister's not on the list ofdisqualified people.
And I know you're thinking, butMatt, I thought family was
prohibited.
It depends on who they are inthe family.
Your brother or sister areactually fine.
Okay, your aunt, uncle, cousin,obviously third parties, some
seller you don't even know,that's totally fine.

(05:54):
The real issue here is thesecertain family members that are
disqualified, do not transactwith them.
It'll blow up your IRA.
You have a distribution of yourIRA, it no longer exists.
If you're not yet 59 and a half,you have an early withdrawal
penalty.
So those are some easy exampleshere, I think, to get the juices
flowing about what we're talkingabout.

SPEAKER_01 (06:12):
And to give you kind of like why the practical reason
why is the IRS knows you wouldnot screw over your mom or dad
in a transaction, but you'dscrew over your sister.
And that's okay.
They're like, that's fine, youknow?

SPEAKER_00 (06:23):
Yeah.
But so or they thought, or theythought, you know, your mom or
dad wouldn't collude in atransaction with you to avoid
taxes, but your brother andsister I don't know what they're
thinking.
Actually, let's let's not evenworry about this.
This try to think what Congresswas intending when they were.
Yeah, that's almost impossible.
That's a disaster.

SPEAKER_01 (06:41):
Yeah.
No, I actually think I'd likeyour example because I do want
to say it.
The IRS actually thinks your momand dad would collude with you
to increase the value of yourIRA and screw over the IRS, but
your sister would be like, hellno, just buy my house.
You know, you jerk.
And so that's kind of what'sgoing on there.
Um, okay, now that's theacquisition transaction issue.

(07:03):
Okay, so everybody, let's let'sknock these out.
So when you're using your IRA tobuy assets, you can't buy
something from yourself, yourparents, your kids.

SPEAKER_00 (07:12):
Uh, you know, the spouse and all the spouses for
the NBU in Utah.

SPEAKER_01 (07:15):
Kind of yeah, there you go.
Now, the next rule that you wantto be aware of is kind of this
use and kind of transactionstuff.
Like, once I buy the property,so I buy it from a third party,
it's all good.
But now you want to go staythere.
Say it's a short-term rental, orit's a long-term rental and you
want your kids to go live in itwhile they go to college, or um

(07:38):
you want you buy this businessand you want the business to
hire you or hire your kids.
Um, but your IRA owns it, and weknow that the IRA could very
well make more money becauseyou're gonna play games with
this, or benefit your familywith money that's stuck in your
IRA, and it could go both ways.
Some people want their IRA toown the business so that it can

(07:59):
suck money out faster.
Other people want the IRA to ownit so you can work in it for
free and make it go up faster.
You never know.
So the IRS says, with all thatcrap going on, no, you can't do
it with these prohibitedparties.
Once you buy something, leave italone.
Go make some money, but don'ttransact with it.

SPEAKER_00 (08:16):
Yeah.
So now my IRA owns that duplexthat I bought from my sister,
not a disqualified person,right?
I can go rent it.
I can have any tenant that Iwant to rent that property, but
it's not me, not my spouse, notmy parents, not my kids, anyone
on this disqualified personlist.
All right.
And also, you can't stay therefor free.
Okay.
So whether you you're having adisqualified person rent from

(08:39):
there, that's a problem.
They're they're transactingbecause they're paying rent to
your IRA, or you're stayingthere for free and getting some
unfair benefit, this causeswhat's called a self-dealing
transaction prohibitedtransaction.
So the bottom line is once yourIRE owns an asset, don't have
use or benefit of it yourself orany of these people that are
disqualified on the list.

(08:59):
Now, for 99.99%, well, I say for99.98% of you, all right, let's
be precise here.
Um, this doesn't matter.
But we know we run across thepeople that are like, they're
trying to manipulate and use theIRA some way unfairly to benefit
them or their kids or theirspouse, or they think that the
self-directed IRA gives themthis freedom to use it in these

(09:20):
ways that benefits them.
No, that's not what we'retalking about here.
You are investing in that duplexbecause you think it's going to
appreciate in value and cashflow rent better than the mutual
fund that your IRA owned before.
That's why we're buying theseassets, not to have some weird
use or benefit from them or todo some crazy transactions to
screw over the IRS.
And so that's what thisprimitive transaction rule is
really all about at the end ofthe day.

SPEAKER_01 (09:42):
I love it.
And you know, and the reality issome of you are like, well,
that's that's not thatcomplicated.
That makes sense.
And it actually is quite easy toabsorb and understand and then
put into practice.
So I think we're ready foranother, you know it's a
prohibited transaction when.
All right.

SPEAKER_00 (09:59):
May I?
Yeah.

SPEAKER_01 (10:00):
Okay.
You know it's a prohibitedtransaction when your IRA buys a
rental and your mom is thetenant and she pays rent in
cookies.
I love that one.
Because your mom would do that,you know?
Yeah.
Like, do I have to really payrent?
Can I just bring you a plate ofcookies?
Yeah.
Um, mom, that is a prohibitedtransaction transaction.

(10:20):
You shouldn't even be there.
Get out.
I'm gonna go to trip go to jail.

SPEAKER_00 (10:24):
So yeah.
A couple more points there.
Fixer uppers.
Okay, yeah.
Fixer uppers.
We a lot of clients areinvesting in real estate that
needs to be fixed up, or they'rebuying businesses, frankly, that
need someone to get in there andrun it and turn it around,
maybe.
All right.
Now, whether you're buying realestate or you're buying a
business, a lot of our clientsthat are business owners, real
estate investors, they're like,I'm going in, I'm going in, put
me in, coach.
You know, I'm putting on thetool belt to go remodel the

(10:46):
kitchen.
The IRS is like, no, you're not.
All right, okay.
That is self-dealing becauseyou're adding value to the asset
past doing administrative andmanagement oversight.
So once your IRA owns realestate, let's just stick with
that one here for a second, keepit simple.
We can have the kitchenremodeled, but your IRA is gonna
pay someone to come do it.
It's not gonna pay your kid oryour or your parents or

(11:08):
yourself.
It can pay some contractor, ofcourse, unrelated, to come in
and remodel and improve thekitchen.
And that's presumably gonnaincrease value or get you better
cash flow.

SPEAKER_01 (11:16):
And by the way, can I just say this is okay?
Now I know some of you listeningare like, well, I'm not gonna
have my IRA do that because I'ma fix and flip expert and I make
half my money when I start goingin to make them better.

SPEAKER_00 (11:26):
If you were a fix and flip expert, you actually
don't work on your properties.

SPEAKER_01 (11:30):
Fair enough.
Okay, that's a good point.
And also I used a key wordthere.
I said, I make half my money byadding value through my sweat
equity.
Well, what was the key word inthere?
Half the value.
Just just don't, you don't needthat extra half because
remember, your IRA can sell thisproperty tax-free.
So you just don't, just youdon't have to have all the cake

(11:51):
and eat it too.
Say, all right, I'll hire acontractor for this sweat equity
stuff.
My IRA is still gonna make agreat return, not as much as if
you did it yourself.
Granted, we get that.
But don't create a prohibitedtransaction by going and working
on the property.
If you were audited, you'd haveto show receipts of actually
paying third parties to improvethe property.

(12:12):
You're still gonna make a greatROI and you don't pay tax on the
deal.
Just enjoy that.
You don't have to have it all.
Don't get greedy.
So that is that sweat sweatequity rule of adding something
to your business or addingsomething to that rental
property that you normallywould.
Go do that with your own LLC.
Just don't do it with the LLCthat your IRA owns.

SPEAKER_00 (12:33):
Yeah, absolutely.
And so um But you can be themanager of the LLC.
Yeah, you can.
So the IRS says, like, hey, lookover things.
You can even go to the property,you can oversee the make sure
the work was done properly.
All this administrativeoversight management, totally
fine.
Your IRA can even own an LLC100%, and the LLC can own the

(12:54):
property and you can be managerof the LLC.
This is called an IRA LCcheckbook IRA.
We've got a lot of other contenton that if you want to read up
on that.
Very popular, of course, forreal estate investors.
Now let's go over to thebusiness too.
Your IRA buys a business.
Go hire, the IRA is going to payfor a manager, or the cash flow
from the business is gonna payfor a manager.
You're not gonna be the oneworking in the business,
particularly when your IRA owns50% or more of that company.

SPEAKER_01 (13:16):
And uh just to give you, you may say, well, that
sucks or whatever.
Just know there's someguardrails.
For example, if your IRA owns aminority interest, you might be
able to work in the business.
Now, when you do a consult withone of our tax lawyers, they'll
tell you where that line isbecause it's a it's a subjective
line.
The case IRS case law says 50%hell no.

(13:40):
If you own 50% or more of thisbusiness in your IRA, you are
not working for it.
That's prohibited.
But somewhere between 49% and2%, there might be flexibility.
It depends on who owns the other50% plus, the majority.
Just know there are some optionsthere, but you and family
cannot, and your IRA cannot owna majority of this company and

(14:02):
you work for it.
So you'll get to know thoserules.
And maybe like if Matt's IRA orsomeone uh owned an IRA and he
wanted to hire someone to workfor it, that's great if they're
not family.
It it's it really looks at whohas majority control of the
company and would they normallypay someone to do this and how
much.
That's their iris is reallyletting people just kind of

(14:23):
self-regulate.

SPEAKER_00 (14:24):
Yeah, and once we're below 50%, it gets into this
self-dealing issue and it's allfacts and circumstances.
Did your IRA own 5% or 49%?
If it frankly owned five, we'renot gonna really care.
If you're at 49%, it's gonna besuper aggressive.
Then also it's gonna look atwhat was the compensation you
were receiving.
Did you actually show up forwork every day and do this as a

(14:44):
job, you know?
So it's gonna kind of get intofacts and circumstances.
Now, there are a lot of cases onthis actually, and they're in my
book.
I have a whole chapter onself-dealing primitive
transactions, probably 10 to 15uh opinion letters, revenue
rulings, cases out there on thisself-dealing primitive
transaction issue.
So if you want to geek out on itor you want to test, know where
the limits are, this is whereit's not as cut and dry as we've

(15:06):
been talking up to here so far.
But our lawyers at Kick YoastLawyers can help.

SPEAKER_01 (15:10):
Okay, you ready for another one?
Yeah.
Okay.
This is a good one.
We're gonna do the joke.
Yeah, I'm gonna I'm gonna tellyou, okay, you know it's a
prohibited transaction when youuse your IRA to buy a fixer
upper, and the IRS shows upbecause your sweat equity is
literally sweating.
Get it?
You're you're sweating, workingon it.

(15:30):
I get it for sure.

SPEAKER_00 (15:33):
Okay, first of all, no good comedian finishes his
joke and says, get it, get it,because this well, you know, I
mean some of us have a littlemore humor.

SPEAKER_01 (15:45):
Well, you know, I'm just trying to bring it out of
you.
When a joke lands, it justlands.
Okay.
All right, you try one here.
Okay.
You go with that with that solo401k.
Okay.
Okay.

SPEAKER_00 (15:54):
All right.
So you know it's a prohibitedtransaction when your solo 401k
buys a business and yourbusiness card says president,
treasure, and guy who definitelypretends this isn't
self-dealing.

SPEAKER_01 (16:08):
Yeah, we're we're nerds.
We pen drop, we don't mic drop.
Okay, I got I'll see.

SPEAKER_00 (16:13):
We got Mark Kohler in this one here.

SPEAKER_01 (16:15):
Oh, okay.
You know it's a prohibitedtransaction when you tell Mark
Kohler, don't worry, I only usedmy IR, my IRA credit card for
one tank of gas, and he passesout like a fainting goat.
Oh, I don't know about that one.
Okay, you want to just we'rejust going with these.
Okay, you read that you go withthat one.
Yeah, that one sucks.

(16:35):
All right, then let's try thisone.
You know it's a prohibitedtransaction when your IRA LLC
writes you a check and you callit a management fee, and Matt
Sorensen suddenly appears behindyou, like, nope, try again.

SPEAKER_00 (16:49):
You know it's a prohibited transaction when you
refer to your IRA owned rentalproperty as our little getaway
place.
And Mark Kohler says, Who's R?
Yeah, who is R in that equation?

SPEAKER_01 (17:00):
Okay, I'd love it.
Okay.
Um, let's do one more and let'steam.
You know, team team play the I'mgonna try and set you up.

SPEAKER_00 (17:09):
Okay.
I'm gonna throw the alley oopand you're gonna throw it down.
Okay.
Okay.
All right, all right.
All right.

SPEAKER_01 (17:15):
So you know it's a priveted transaction when your
IRA owns an Airbnb and has aglowing five-stair review from
aka definitely not the owner.
Uh which means you cannot stayin your own Airbnb that's owned
by your IRA.
I should say you cannot stay inan Airbnb that's owned by your

(17:36):
IRA.
Yeah.
Anyway, I I hope that was funand a few of those, but you're
getting the the gist here thatwe actually have a lot of these
questions come through to us.
And we should probably do that,take more of those.
But um, this is something thatyou shouldn't be afraid of.
It's easy to understand thisrule, and it's so easy to make

(17:57):
more money in your IRA justplaying in the right in in the
right lanes.
You don't have to get a gooff-roading and start taking
risks to be successful at thisand and just rapidly increase
the value of your IRA.

SPEAKER_00 (18:11):
So yeah, and we got tons of resources here.
You can book a call with ourteam, they can help you go over
the resources, understand andeducate you on this.
And if you have crazycomplicated questions, you're
like, but I want to do a dealwith myself or anybody who's a
disqualified person or this LLCthat I'm a part of, that's where
you want to talk to your taxlawyer or CPA, our firm of KQS
Lawyers can help you with that.
Also, my book, the self-directedIRA handbook.

(18:33):
I hate to plug it, but youshould.
You know, yeah, it is the numberone book in the field.
Government regulators,literally, buy my book.
Other competitors in theindustry.

SPEAKER_01 (18:41):
I normally wouldn't brag about that, but he does.

SPEAKER_00 (18:43):
I'm just saying that, you know, if they're
trying to learn this, where dothey go?

SPEAKER_01 (18:48):
Yeah.

SPEAKER_00 (18:48):
Just saying.

SPEAKER_01 (18:49):
Really, they're stalking him.
It's you know, you're looking atjust glass half full.
I like that.
But you know, they loved it.
Yeah, yeah.
I mean, if the feds have awiretap on you, it's you know,
probably a good thing.
They're trying to learn fromyou.

SPEAKER_00 (19:03):
Man, you really spun that the wrong way.

unknown (19:05):
Jeez.

SPEAKER_01 (19:06):
No, it's no, I love it.
It is the best-selling book, andI love it.
I have a copy of it on my desk.
You guys should as well.
Uh, don't give up.
Keep investing.
Know that you control yourretirement, no one else, and
you're gonna be the best personto determine what really
investment is gonna work bestfor you and get you the greatest
return.
So keep listening, please.
Uh, we're gonna be here everyweek trying to help you on your

(19:29):
American dream and building yourretirement account.
If you enjoyed this, please giveus a five-star, two thumbs up,
double high five, whatever.
And uh, we'll see you next weekfor another episode of the
Directed IRA podcast.
And thank you everyone forlistening.

A quick disclaimer and reminder: this presentation does not (19:43):
undefined
constitute an attorney or CPAclient relationship, and it is
always in your best interest toconsult competent legal and tax
professionals when conductingyour own personal transactions.

SPEAKER_00 (19:58):
We also want to make sure you know this is not
investment advice or financialadvice.
We're just trying to give youeducation, ideas, and strategies
you can take to yourprofessionals or conduct your
own research on.
We'll see you next time.

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